Canadian retail stocks hit by Target, Wal-Mart

Canadian retailers’ stocks have dropped to their lowest level since January 2005 compared with U.S. peers amid increasing competition from Wal-Mart Stores Inc. and Target Corp., the biggest American discounters.

The ratio between the S&P/Toronto Stock Exchange Retailing Index and its counterpart in the Standard & Poor’s 500 narrowed to 4 on Feb. 11, the smallest in six years, according to Bloomberg data. The retailing index has retreated 2.3 percent this year, while a separate index of companies that sell food and basic necessities has lost 1.1 percent, the biggest declines among 24 industries in the S&P/TSX.

Target agreed to spend C$1.83 billion ($1.86 billion) to buy leases for as many as 220 sites in Canada last month, expanding outside the U.S. for the first time. On Jan. 26, Wal- Mart said it will open 40 more supercenters that combine grocery and general-merchandise sales in Canada through January 2012, bringing its total to 164.

“We have seen a number of names react negatively to the news that Target is entering,” said Candice Williams, a retail analyst at Canaccord Financial Inc. in Vancouver. “On top of that, if you look at staple names, we have Wal-Mart announcing further plans, and the question we hear from clients is, ‘to what extent, with all the new competition in grocery, will food inflation be able to be passed through to the consumer?’ ”

World food prices rose to a record in January as dairy, sugar and cereal costs increased and will probably remain elevated, the United Nations said on Feb. 3.

Canadian Tire Corp., Canada’s largest general-goods retailer, has slipped 5.8 percent this year, while Home Depot Inc. has gained 8 percent. Empire Co., the No. 2 Canadian grocery chain, has declined 3.9 percent, compared with a 3.9 percent advance for Kroger Co., the largest U.S. grocer. Wal- Mart has gained 1.2 percent. Target has slumped 11 percent after missing analysts’ average estimate for December sales.

The sites Target bought are now occupied by Zellers, Hudson’s Bay Co.’s discount chain. Target, based in Minneapolis, plans to open its first 100 to 150 Canadian stores in 2013 and 2014.

Target recorded net income of $535 million and had free cash flow of $408 million in the third quarter and $587 million of cash on its balance sheet as of Oct. 31. Hudson Bay cut 1,000 jobs in 2009 and reduced staff again last year, according to the National Post.

“Where you had a weak competitor, now you have Target, which has ample cash flow to invest in its stores,” said Alec MacIsaac, senior investment analyst at Tetrem Capital Management Ltd. in Winnipeg, Manitoba, which oversees about C$6 billion. “That is clearly negative for retailers who sell discretionary merchandise.”

Canadian companies most likely to lose customers from Target’s entry include Canadian Tire and grocery chain Loblaw Cos., which has been expanding non-food sales in recent years, MacIsaac said.

Tetrem’s CI Canadian Investment Fund holds about 1 million Canadian Tire shares. The fund has kept the shares because they are relatively inexpensive and the company may raise its dividend, MacIsaac said. Canadian Tire trades at C$11.75 per dollar of estimated 12-month future profit, compared with C$15.57 for the S&P/TSX.

Wal-Mart’s expansion in Canada comes at a problematic time for food and basic necessities retailers, MacIsaac said. Profit margins decreased last year as consumer food prices failed to climb significantly, yet share prices surged the most since 2001 on forecasts food inflation would return. With Wal-Mart providing more competition, that may not happen.

“Everyone is competing for dollars, and so the belief is it will be hard for grocers to pass along food inflation,” said MacIsaac, whose firm owns shares of Empire. “Therefore, margins are hurt, and a lot of investors are avoiding them.”

While Canadian grocery prices increased 1 percent last year, the least since 1994, the World Bank said this week that global food prices have surged to dangerous levels, pushing 44 million more people into extreme poverty since June.

Pessimism over Canadian retailers isn’t universal. Loblaw, Empire and No. 3 Canadian grocer Metro Inc. each have more “buy” ratings from analysts than “hold” and “sell” ratings combined. Six of the seven analysts who cover Forzani Group Ltd., the country’s biggest sporting-goods retailer, rate the company a “buy.” With the exception of one downgrade of Forzani shares to “hold” from “buy,” the ratings haven’t changed this year.

“There’s going to be an impact, but I do think people have overreacted and really sold off these stocks,” said Brian Yarbrough, an analyst who tracks Canadian consumer stocks for Edward Jones & Co. in St. Louis. “It’s created some good buying opportunities on the Canadian Tires and Loblaws of the world.”

Loblaw’s price per dollar of analysts’ forecast profit fell to the lowest since at least 2005 last month. The valuation of Reitmans Canada Ltd., the country’s largest chain of women’s apparel stores, has fallen to the lowest since April 2009.

Canadian retailers have demonstrated their ability to withstand foreign competition over the past 25 years, said James Cole, who oversees C$800 million as a money manager at Portland Investment Counsel Inc. in Burlington, Ontario.

Wal-Mart and Home Depot Inc. entered Canada in 1994 and have since grown to 325 stores and 179 stores, respectively. Best Buy Co. opened its first Canadian location in 2002, and Lowe’s Cos. followed in 2007. Limited Brands Inc., which bought Canada’s La Senza lingerie chain in 2007, introduced its Victoria’s Secret brand in Canada last year.

Canadian Tire and Loblaw shares have increased fivefold since the end of 1994.

Canadian Tire’s third-quarter sales equaled 2 percent of all retail sales in Canada, about the same as in the third quarter of 2005. Forzani’s share of the Canadian retail market has increased by 3.4 percent during that time.

“I don’t think it’s so worrisome to the stronger, better- managed companies,” Cole said. “Canadian retailers have faced this for a long time. Weaker chains that used to exist have long since met their maker, and the stronger ones — like Canadian Tire, Loblaw, Metro — have thrived.”

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